Duties and responsibilities of those charged with governance: formula sheet

Key formulas

Definition

Corporate governance = the system by which a company is directed and controlled

Use this wording to open a definition answer.

Four core principles

Accountability + Transparency + Fairness + Responsibility

Memory aid: ATFR. Be ready to define each in one sentence.

Source of the need

Separation of ownership (shareholders) and control (directors) → agency problem → need for governance

This is the reason governance exists.

Directors' core duty

Act in good faith for the company's benefit; avoid conflicts; no secret profit; use reasonable care, skill and diligence

These are the fiduciary duties in plain words. Local law gives exact wording.

Financial reporting responsibilities

Keep records + prepare true and fair statements + safeguard assets + prevent and detect fraud

Use this four-part list to answer most 'responsibilities of directors' questions.

Division of responsibility

Directors PREPARE the statements; auditors give an OPINION on them

The auditor's opinion does not transfer responsibility to the auditor.

Accountability chain

Shareholders appoint directors → directors manage and report → auditors give an opinion → shareholders review at the AGM

This is the stewardship cycle.

Directors vs auditors

Directors PREPARE the financial statements; auditors EXPRESS AN OPINION on them

The most tested distinction. Preparation is management's duty; opinion is the auditor's duty.

Who appoints whom

Shareholders → appoint directors and external auditor; audit committee → recommends auditor to the board

Auditors are accountable to shareholders, which protects their independence.

Audit committee membership

Independent non-executive directors only (good practice in most governance codes)

Executive directors may attend by invitation but are not members.

Level of assurance

External audit = reasonable assurance, not absolute assurance

Do not say an audit guarantees the accounts are correct or that fraud is detected.

Executive vs non-executive director

Executive = full-time, runs the business; Non-executive = part-time, independent oversight and challenge

NEDs are not employees and do not manage day-to-day operations, but share collective board responsibility.

Separation of roles

Chairman = leads the board; CEO = leads management

Separating them avoids concentration of power in one individual.

Audit committee

Financial reporting + internal controls and risk + internal audit + external auditor relationship

Mainly independent NEDs, ideally with recent relevant financial experience.

Remuneration committee

Sets executive directors' pay policy and levels

Stops executives from setting their own pay.

Nomination committee

Board appointments + balance and skills + succession planning

Gives a formal, transparent process for appointing directors.

Agency relationship

Principal (shareholders) → appoints → Agent (directors/managers)

Agents must act in the principal's interests. The conflict between the two is the agency problem.

Source of the problem

Conflict of interests + information asymmetry = agency problem

Both parts matter. Managers want personal benefit and know more than owners.

Agency cost

Agency costs = monitoring costs + incentive costs + residual loss

Examples: audit fees, bonus schemes, and value lost despite controls.

Comply or explain

Follow the provision OR disclose non-compliance with reasons

Used in many codes. It is not the same as a legal requirement.

Typical board safeguards

Independent non-executives + separate chair and CEO + audit, remuneration and nomination committees

Common features of governance codes. Details differ by country.

Quick revision

• Corporate governance is the system by which companies are directed and controlled.
• Common principles: transparency, accountability, fairness and responsibility. Exact lists vary by code.
• Directors manage the company and are accountable to the shareholders.
• Directors are responsible for preparing the financial statements and keeping adequate accounting records.
• Auditors are independent of management and give an opinion on whether the financial statements are presented fairly.
• Auditors do not prepare the financial statements and do not run the company.
• Shareholders own the company and usually appoint directors and auditors.
• Agency problem: agents (directors) may act in their own interest rather than the principals' (shareholders').
• Non-executive directors are not employees and bring independent judgement to the board.
• Audit committee: reviews financial reporting, internal control and the external auditor relationship.
• Remuneration committee sets pay for directors; nomination committee proposes board appointments.
• Comply or explain: follow the code, or state clearly why you did not.

Common mistakes

• Confusing governance with day-to-day management. Fix: Governance is about direction, control and oversight. Management is about running operations to meet targets.
• Mixing up accountability and responsibility. Fix: Responsibility is having the duty. Accountability is having to explain and answer for how you carried it out.
• Saying the auditor prepares the financial statements. Fix: Remember: directors prepare, auditors report an opinion.
• Thinking an unqualified audit opinion removes the directors' responsibility. Fix: The opinion is reasonable assurance only. Responsibility for the statements stays with the directors.
• Saying the auditor prepares the financial statements. Fix: Remember: directors prepare, auditors give an opinion. The auditor checks, never prepares.
• Claiming the audit guarantees there is no fraud or error. Fix: Write 'reasonable assurance' that the statements are free from material misstatement.
• Saying NEDs manage the company day to day. Fix: Remember that executives manage; NEDs oversee, challenge and advise.
• Treating the chairman and CEO as the same role. Fix: Chair leads the board; CEO leads management. Good governance separates them.
• Reversing principal and agent, calling directors the principals. Fix: Remember the owners appoint the directors. Owners are principals; directors act on their behalf as agents.
• Saying comply or explain means a company can ignore a code. Fix: A company may depart from a provision only if it discloses the departure and gives reasons. Shareholders can then challenge it.

Exam tips

• Learn the four principles with a one-sentence definition each. Objective tests often give a scenario and ask you to name the principle.
• Read the scenario for the main issue. Several principles may relate, but only one fits best.
• For number-of-answers questions, select exactly the stated number and avoid adding extra ideas.
• Keep definitions in your own words; the exam tests meaning, not memorised phrases.
• Link governance to the agency problem when asked why it matters.
• Learn the four-part list: records, statements, safeguarding assets, preventing and detecting fraud.
• Whenever you see the word 'opinion', think auditor. Whenever you see 'prepare', think directors.
• Reject options with absolute words such as 'guarantee' or 'ensure no errors'.